Notes From Underground: The Swedes Plumb the Interest Rate Depths

First, I will say it again. QE3 is over and the Fed will maintain its “forward guidance” and be data dependent. The next bout of important data will be the U.S. unemployment release on November 7, which buys the Fed one more month of doing nothing. James Bullard painted the FED into a tight corner when he PANICKED and said the FED may want to refrain from removing QE3 while the SPOOs and other equity markets were at a 10 percent correction low. Bullard revealed that the Fed’s REACTION FUNCTION is the equity markets and of course Chairman Yellen’s concern about the lag in wages. The two key variables for the Fed have both been steady since the last meeting. The spoos are lower by 0.75 percent while the September unemployment report showed wage gains had no increase.

The FED did raise concerns about the recent appreciation of the DOLLAR in the September 17 release but I doubt we will hear no more about the BUCK. There is no Yellen press conference. The DOLLAR is the responsibility of Treasury Secretary Jack Lew and the FED needs to keep its opinions to itself. Expect to hear about concerns global growth and the potential headwinds European problems can have for the U.S. economy. The FED is not shrinking its balance sheet but only refraining from increasing its size. $4.2 trillion is still a huge amount of reserves to have in the system.

***European areas are still of potential concern. The period of July 2012 becomes an important barometer for measuring the problems within the European financial system. As I pointed out, President Draghi’s famous speech about “no taboos and whatever it takes” put an end to the rise in yields of periphery debt, or, better known as the PIIGS (Portugal, Ireland, Italy, Greece and Spain). The yield curves flattened while two-year yields on sovereign debt dramatically rose as investors feared for the EU’s financial future as insolvency of several European states appeared imminent. Spain’s budget deficit rose with interest rates as bond investors were in a panicked state.

The 2/10 curves across Europe flattened as investors dumped two-years faster than 10-year bonds. It was only during July 2012 that yields on two-year Italian and Spanish notes were yielding close to 8 percent. Imagine ,Spain had over 20 percent unemployment and yields were climbing dramatically. The present situation is much different as two-year yields across Europe are exceedingly low as the fear is deflation and not insolvency. More importantly, global investors believe that the euro will be the currency for all EU members and thus the fear of an EU break-up is not even being considered. Two-year note rates are as follows:

Ireland: 0.047;

France: 0.011;

Spain: 0.514;

Italy: 0.678;

Portugal: 0.956; and

Of course Germany, Finland and the Netherlands all have negative rates.

While the 2/10 yield curves have flattened somewhat as deflation pressures have recently increased, the overall yield curve indicators show somewhat healthy curves unlike which took place in 2012. The two-year yields and the curves will be important proxies for any financial problems within the EU so I am just making readers aware of where to look for any signs of ECB and Brussels policy failures. If the market fears that President Draghi has failed to provide the needed liquidity to the financial system solvency risk will increase dramatically and the two-year note will be our guide.

***The RIKSBANK strikes again! This is the most important story of the day. The Swedish Central Bank lowered its lending rate to ZERO in an effort to halt a slide into deflation. In a piece in the London Telegraph, Ambrose Evans-Pritchard writes, “Riksbank Cuts Rates to Zero and Mulls Currency War to Fight Deflation.” The Swedes surprised the markets on July 3 by cutting the overnight rate 50 basis points, while today it cut the rate 25 basis points to zero. Previously, the Riksbank has been worried about a growth in credit as private debt has risen over the last 12 years. As AEP reported: “The ratio of household debt to disposable income has jumped from 120 percent to 175 percent … It is expected to reach 185 percent by 2017.” Deflation is a very dangerous economic outcome for a country with a large public and private debt load. It is why I keep discussing the impact of 1937 on the work of Ben Bernanke and why he obsessed about removing FED stimulus until he was sure of price stability, meaning inflation of 2 percent.

Riksbank Governor Stefan Ingves admitted that depreciating the Swedish kroner was one of the tools in the central bank’s arsenal. The EUR/SEK cross rate has been rangebound since the July 3 surprise as the euro has held between 9.06 and 9.3580. Yesterday, the EURO/KRONER cross closed at 9.3450 after making a new high for the year at 9.3850. It closed at 9.3480, a four-year high for the EUR/SEK, indicating the Riksbank efforts to weaken the currency. This is a problem for ECB President Draghi as he comes under increasing pressure from France and Italy to enact policies to depreciate the EURO. Mario Draghi’s job is now more difficult as he sees his neighbors weaken their currency to prevent deflation, just as the tide of deflationary fears washes up on the ECB‘s shore.

But the job of the Yellen Fed became easier as global deflationary fears will keep the Fed steady as it goes. More importantly, for the world financial system the G20 agreement of not entertaining policies aimed at weakening a nation’s currency is now officially dead. The global financial system is now in a full-blown war against deflation. Damn the printing presses, debt restructurings, currency devaluations and full speed ahead. I wonder if Sweden will get a Nobel Peace Prize for its efforts. The global equity markets comprehend that deflation is the common enemy. What new policies await the markets? Is this what Joseph Schumpeter meant by CREATIVE DESTRUCTION?

4 Responses to “Notes From Underground: The Swedes Plumb the Interest Rate Depths”

Yra,
Great post as usual, especially Riksbank doing a 360 over the past 4 years! The Temptations “Ball of Confusion” now themes the policymakers.
“The sale of pills are at an all time high
Young folks walking round with their heads in the sky
The cities a flame in the summer time
And oh, the beat goes on

Evolution, revolution, gun control, sound of soul
Shooting rockets to the moon, kids growing up too soon
Politicians say more taxes will solve everything
And the band played on

So, round and around and around we go
Where the world’s headed, said nobody knows
Oh, great Googamooga
Can’t you hear me talking to you?

Just a ball of confusion
Oh yeah, that’s what the world is today
Woo, hey, hey

Fear in the air, tension everywhere
Unemployment rising fast, the Beatles new record’s a gas
And the only safe place to live is on an Indian reservation
And the band played on

Eve of destruction, tax deduction, city inspectors, bill collectors
Mod clothes in demand, population out of hand, suicide, too many bills
Hippies moving to the hills, people all over the world are shouting
‘End the war’ …..
And the band played on……

Yra- I am sure this is what you were alluding to in your Schumpter comment, but apparently the new “Masters of The Universe” (CB’s) do not allow natural destruction in markets of any kind anymore under any circumstances if they can avoid it. Apparently productive capital allocation is not a concern, just make sure prices are rising. As you have pointed out, “we are all 37’ers now.” It’s hard fading the Fed’s orthodoxy given their large fire power, but it would seem to be getting increasingly easier precisely as so few want to do it anymore.

P.S. Until the reserves held at the Fed relative to M1 drops from the crazy 64% any reduction in QE may have a larger effect than expected. However, I am of the opinion that this ratio will likely fall as reserves will leave the Fed and replace the lost monthly addition of liquidity. Something to watch. That being said I never thought we would still be above 60% given the activity in buybacks, M&A, and the continued rise in asset prices. A bit of a conundrum to me.